Generally, once a contract is agreed it becomes legally binding and the parties involved will be lawfully obliged to perform as per the contractual terms and conditions. In reality, however, it is not always that straightforward and things can often go awry.
If one signatory believes that the contract is not being upheld from the other end, depending on what that breach may be, they could choose to either affirm the contract and claim any resulting damages; they may attempt to terminate the contract, or they could seek to legally cancel or rescind it altogether.
But in what way do these actions differ and how will the parties involved be impacted? In this article, we take a closer look at how contracts work and what is meant by the terms rescinding (cancelling) or terminating.
Terminating a contract
To terminate a contract both parties need to have met the obligations set out within the contract, such as confidentiality clauses or restrictive covenants. Terminating essentially brings the contract to an end, putting the parties back in the position whereby it is as if the contract had been completed.
There will be an express termination clause in the contract itself, which can be triggered by giving notice to the other party. It can also occur where there is an implied clause, which permits parties to terminate under common or statute law, or even automatically. For example in instances where the contract has been frustrated).
Termination clauses can, on occasion, be unilateral, which, dependent upon the wording of the express clause and the circumstances, could give rise to an unfair contract term argument.
Rescinding a contract
Rescinding a contract will see both parties restored back to the position they were in before the contract was agreed. When a contract is rescinded, it will be as if the contract never existed, ultimately removing all contractual obligations.
Rescission is a reasonable remedy when one party has committed a breach of contract, usually through misrepresentation or mistake.
However, rescinding will only be applicable if the contract has not been previously affirmed.
Affirming a contract
Affirming a contract refers to when contractual terms continue to be applied even after a repudiatory breach has occurred. This will usually be done where the wronged party intends to claim damages in light of such a breach.
A repudiatory breach of contract is where one party fails or refuses to perform a fundamental term or condition within the contract. The other party can at this point choose to either accept that repudiatory breach of contract and rescind the contract, or continue with the contract (thereby affirming it) and claim damages instead. The unique circumstances of the conflict will normally dictate which will be the best option for the party not in breach.
This is usually the primary reason why rescinding a contract needs to be done promptly upon the occurrence of a sufficient breach. Any delay in this process could be used by the opposing party to argue that the contract had in fact been affirmed, meaning that the chance to rescind will have been missed.
To rescind or affirm?
Because rescinding will render a contract non-existent in retrospect, the innocent party will need to deliberate what their preferred outcome will be. This could include the return of valuable property, for example.
Rescinding a contract is not something that will be initiated by a court; it must be done by either of the contractual parties. The innocent party should first inform the offending party of their intentions and if the breach is subject to litigation, the court will then decide whether it is legally sound to rescind the contract.
The court will not find rescission valid if it believes the contract was affirmed, if a third party has acquired rights to any property subject to the rescission, or if it is no longer possible for the parties to be restored to their prior positions (as if never entering into the contract).
Both sides of the transaction must be able to return to their original position in order for a contract to be rescinded. In some instances, this may be difficult purely because of the nature of the business, in others the property involved may have been substantially altered.
All the circumstances have to be fully analysed before any decision is made, as exercising a rescission cannot be undone.
Exit strategy
Negotiating an exit from a contract can be exceptionally complex, particularly if it is dependent upon whether one of the parties is in breach or not. These decisions should never be undertaken without expert legal counsel to advise on the best course of action, as failure to do so could be catastrophic for the future of a business, both financially and with regards to reputation.
- Katarina Morgan is a solicitor in the commercial litigation department at Taylor Walton.